- 20 Mar 2012 at 12:49 PM
I’ve sort of resisted writing about Apple’s capital return thingy because, yeah, that basically makes sense, they have more money than they know what to do with and more coming in each day, so their choices are pretty much (1) give some of it back, (2) find something super-awesome to spend it on, (3) find something dumb to spend it on, or (4) engage in weird experiments in macroeconomics and/or exponential growth where they end up having more money than there is in the world. I don’t have any super-awesome ideas to spend it on (and also I trust Apple to know better than I do what it’s good at doing); spending it on dumb things seems … dumb; and I don’t think the weird experiments will work though you never know! That leaves “give some of it back.” So you can say something like “yeah this makes sense” or “I would’ve done it slightly differently,” or you can go and say something silly. Like:
Gregory Milano of Fortuna Advisors, which advises Fortune 500 companies on maximizing their market value, did some quick math. Milano considers buybacks to be like any other investment a company can make. Buybacks must offer a good return in order to be deemed a smart use of capital. That is, if a company buys its stock at $10 a share and it rises to $12 next year, it’s earned a 20% “return on investment” for shareholders. Because the average business’s capital costs run 10% a year, between debt and equity expenses, most companies should seek buybacks to return more than 10% a year if they want to build shareholder profit.
In Apple’s case, returns on capital are extraordinary. The tech giant earns around a 40% return on its operating capital, far exceeding its capital costs. So what’s a good hurdle rate, or minimum rate of return, for its buyback? Milano thinks a 20% “return on investment” is fair.
For the buybacks to deliver that return, Milano says Apple’s stock price will have to rise 128% to $1,368 over the next five years. For a meager 10% buyback return, the stock needs to hit $984 in five years.
Can the stock reach those heights?
You make the call! I will not be making that call because feh. Here is my model of Apple:
(1) People entrust it with money to build stuff
(2) If it can build stuff at a 40% IRR, it should go do that
(3) If it can build stuff at a 39% IRR, it should probably go do that
(4 – 40) If it can build stuff at an X% IRR, 39>X>1, dealer’s choice
(41) If it can put money into bank accounts at a 1% IRR, it should probably give that money back to shareholders who can, y’know, also put it in the bank at 1%, or do something else.
You can interpret the present situation in various ways but you’d have to at least consider the possibility that, loosely speaking, Apple has captured the projects where risk-adjusted X > 1%, and is kind of out of ideas that are better than parking its cash in the bank. Because otherwise it would be doing those ideas instead of parking its cash in the bank.* Part of why Apple’s returns on capital are extraordinary is because it invests its money in really good projects. If it doesn’t have any more of those, it makes sense to give some of the money back. In other words, your hurdle rate in deciding whether to return capital can’t be your cost of capital. (Right?)
But you can’t really blame Mr. Milano of “Fortuna Advisors, which advises Fortune 500 companies on maximizing their market values,” because holy shit he advises Fortune 500 companies on maximizing their market values!** How could that be a goal? And the answer is, you know how: managers like to have high market values. One way to reduce your market value would be to give cash back, though I have a feeling it won’t work here.
Meanwhile in another part of town a man did not attend a meeting:
Facebook Inc. chief executive Mark Zuckerberg doesn’t expect to play a hands-on role selling the social network’s initial public offering to analysts, one Facebook executive told Wall Street analysts Monday.
The company is also planning to pay a below average fee to underwriters of the stock sale.
On Monday, Mr. Zuckerberg skipped a meeting of analysts and bankers at Facebook’s Menlo Park, Calif., headquarters, according to people familiar with the meeting. In response to a question about his absence, the company’s chief financial officer, David Ebersman, said Mr. Zuckerberg preferred to focus his time on developing the service rather than play a role with such analysts, the people said.
Senior Facebook executives, however, haven’t made any decisions yet on the role Mr. Zuckerberg will play in a so-called roadshow to sell the company’s shares to investors, or the larger IPO process, said one person familiar with the matter.
Obviously the stronger move here would be to attend the meeting, but stare out the window the whole time and comment on the weather, and then some snotty analyst would be all “Mr. Zuckerberg, do I have your full attention?” and YOU KNOW THE REST. But this sends the same message I think which is “this process has the minimum amount of my attention.***”
Which makes sense. Facebook doesn’t need the money from its IPO, except hilariously to pay taxes incurred by its IPO, and it’s actually borrowing money to do that. (Presumably because L+100 money is cheaper than expected returns on Facebook stock.)
You can see why this sort of thing gets people mad. The notion that companies are supposed to be run for the benefit of shareholders, which I guess makes sense as a first approximation, sometimes grows into the less sensible notion that the most important thing for a CEO to do is to think thoughts about his shareholders. Apple and Facebook have the luxury of mostly not having to play to that perception – Apple because it’s the biggest company in the galaxy and also because it’s ridiculously profitable so shareholders are happy even without a lot of touching and stroking, Facebook because Facebook Facebook Facebook Facebook and also because it doesn’t really want their money. So they wind up treating their capital like they’d treat other inputs to their enterprise: using only as much as they need, returning what’s not being used, and delegating its management to specialized executives rather than making it the main focus of their CEO’s time. It all makes total sense if you’re not too romantic about the role of shareholders. It just doesn’t do much for market-value consultants and capital markets bankers.
* I mean, really loosely speaking. Not really 1%. But it’s probably safe to say that all the guaranteed 20% IRR projects are budgeted for in the four hundred kajillion dollars they’re hanging on to.
** He probably doesn’t really. To be fair, Fortuna’s principles seem a bit more plausible than that, although also confessedly “postmodern,” which, okay. But presumably he’s about shareholder value maximization, not like literally “how to increase market cap.”
Also, I’m generally being unfair to him. He’s probably discussing buybacks as opposed to dividends, not buybacks as opposed to keeping the cash, and there the argument is better though not necessarily a slam-dunk. I’m more in the price-insensitive school of buybacks myself but the other side has its points. So, sorry Mr. Milano. I was just tickled by that specific number. Will they make $1,368? Will they not? The suspense will kill me for five years.
*** “And, incidentally, of my fees.”
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